Question

Amarillo Company experienced the following events during its first accounting period.

(1) Purchased $5,000 of inventory on account.
(2) Returned $50 of the inventory purchased in Event 1.
(3) Sold the inventory for $6,000 cash.
Based on this information, which of the following shows how the recognition of the return will affect the Company's financial statements.
A. decreases assets and liabilities only.
B. decreases liabilities and assets and shows up as an expense on income statement.

Answer 1

The recognition of the inventory return by Amarillo Company will decrease both assets and liabilities, specifically the inventory and accounts payable accounts, and does not affect expenses on the income statement.

Step-by-step explanation:

The recognition of the return of inventory by Amarillo Company affects the financial statements by decreasing both assets and liabilities. When the company returns $50 of inventory, the inventory account, which is an asset, decreases by $50 as the company no longer has this inventory. Simultaneously, the accounts payable (liabilities) also decrease by $50 because the company returns inventory that was initially purchased on account, reducing the amount it owes to the supplier. The transaction will not be recorded as an expense on the income statement since it is a return of inventory, not an actual expenditure. Rather, it will adjust the cost of goods sold if the accounting period has not yet closed. The correct answer is A. decreases assets and liabilities only.